Policy Papers

Financing health care in Britain since 1939

Rodney Lowe | 13 May 2002

Executive Summary

In January 2000, two decades of relative resource constraint on the NHS were ended by the commitment to raise UK health expenditure to the European average. Two ambitious reform plans followed (The NHS Plan, 2000; Wanless 2002) together with an expressed preference for the UK's unique tax-based system (Wanless 2001). The 2002 Budget raised national insurance contributions (NICs) to fund a real increase of 43% in NHS spending by 2007/8, thereby raising health expenditure from 6.8% to 9.4% of GDP.

Why was the unique system of tax-funding adopted in the UK in the 1940s?

Why was it not reversed in the 1950s when Conservative governments sought to reintroduce an insurance based system? The consequence was that their 10 year modernization programme (the 1962 Hospital Plan, launched by the economic liberal, Enoch Powell) further entrenched the tax-funded system.

Has policy become, in Paul Pierson's phrase, path dependent - with the 1940s and 1950s marking the 'critical juncture'? In other words, since that time have any possible advantages from a fundamental change to the financing of the NHS been outweighed by its costs? This was the apparent conclusion drawn by the Thatcher government in the 1982 and 1988. Alternatively, is the time now right - as in the 1940s - for a paradigm shift?

Five policy suggestions follow from this analysis.

Caveats

All discussions of the NHS come with appropriate health warnings. In this context, there are five:

NHS does not stand for a national hospital service. A fixation on e.g. waiting lists distorts analysis.

The NHS is not synonymous with health care. Health outcomes can typically be better improved by expenditure on other services (e.g. the personal social services, housing). These services raise different financial issues.

Health systems throughout the world are 'in crisis'. There is no perfect system. The French social insurance based system, adjudged by WHO in 2000 as the world's best system, is increasingly switching to tax-funding.

How money is spent is more important for health outcomes than how it is raised. (Support for social insurance is based, however, not just on the argument that it does not crowd out private health expenditure but that it also creates a more responsive administration. In other words, how money is raised can affect the way in which it is administered and spent.)

From its inception, and whatever its actual delivery record, the NHS has enjoyed exceptional popularity. The most recent opinion poll recorded that 80% of those polled regarded the NHS to critical to British society and that 75% opposed the creation of a two-tier system (Wanless 2001).

Why was a unique funding system adopted in 1948?

In the 1930s, the UK had a conventional mix. For example, 90% of the workforce had social insurance, covering the GP service and sick pay. The other 10% and all dependants either had private insurance or made full out-of-pocket payments. Hospital costs were paid by a similar mix. 10 million people had private insurance (e.g. workers' contributory schemes) and the rest paid means-tested charges. Local and national taxes funded public health and both hospitals and specialist clinics run by local authorities.

The change to a unique, predominantly tax-based mix, was adopted for a combination of pragmatism and principle. This change had popular support and, equally important, met with little resistance from vested interests.

The Beveridge Report in 1942 recommended a service that was universal (covering all people) and comprehensive (covering all needs). Beveridge, rather like New Labour, regarded it as the duty of the individual and government to prevent ill-health. This was to minimize outgoings in benefit and to forestall the creation of a dependency culture dependency. Equally it was to boost productivity (and hence economic growth and general well-being). He personally favoured social insurance to underpin responsible individual behaviour ('previous contribution is the ideal', para 433); and believed the British people thought likewise (interwar experience demonstrated they were 'clearly willing and able to pay contributions for institutional treatment', para 432). In his universal plans, however, the proceeds of flat-rate insurance were swallowed up by other insurance needs, and especially pensions. For pragmatic reasons, therefore, more than two-thirds of the service (expected to be run by local government) had to be paid by national and local taxes. A £40m 'health contribution' would be made from National Insurance, however, to provide government with a similar income to that received under the old social insurance scheme. This amounted to 23.5% of the anticipated gross cost of the NHS. He also favoured hospital hotel charges (para 434) and charges for appliances ('as an incentive for careful use', para 436).

Bevan, as is well known, nationalized the hospital system in 1948. Since local government was no longer to co-ordinate the NHS or to run its own hospitals or clinics, national rather than local taxes came by default largely to fund the service. Bevan also favoured this in principle for three reasons. The first was that national taxation was more redistributive. The second was that he regarded free access to health care to be a citizen's right and not something conditional on the payment of contributions. Finally there was the question of how, politically and administratively, the non-insured could not be turned away from a universal service. He favoured a fully tax-financed system so strongly that he strove to disassociate the NHS from the other welfare services launched on 5 July 1948, 'the appointed day' and conventional birthday of the welfare state. Nevertheless the NI contribution continued and Bevan wavered between supporting charges as a means of checking abuse (in 1949) and rejecting them (in 1951). [The rational and humane care of the frail elderly, pejoratively called bed-blockers by hospital staff by the 1960s, was greatly complicated by the related battle over whether they should be cared for in free geriatric NHS wards or local authority homes, for which a means-tested charge could be made.]

A predominantly tax-based system was favoured popularly at all levels. Manual workers regarded the interwar system as inequitable; and the growth of voluntary contributory schemes did not make hospitable more responsive. The better-off favoured risk-pooling as longevity and the cost of more technically advanced health care increased. Doctors were frustrated by the lack of buoyant revenue, which restricted their clinical freedom. Approved societies (responsible for the competing social insurance schemes) were likewise frustrated by the tight Treasury grip over their freedom of action. Unlike on the continent, therefore, there was little demand for the continuation - and, equally important, little resistance to the dismantling - of the interwar, social insurance based system.

Why did proto-Thatcherism fail in the 1950s?

In the mid 1950s, the Conservatives questioned the desirability of a tax-funded NHS on ideological and economic grounds. Increased affluence meant most people could, and arguably should, provide directly for their own health care. Taxation could thereby be reduced; and this, in an 'opportunity' as opposed to a 'welfare' state, would increase individual initiative, economic growth and thereby individual welfare. The three policy proposals designed to make patients pay more were: the privatisation of supplementary services such as dentistry and ophthalmology; increased charges; and making the NHS fully, or more fully, contributory.

The principle of a fully contributory NHS was discussed in Cabinet in 1957 and in great detail within Whitehall in 1959-1960. The Treasury wished to cap NHS expenditure; have clear agreement over which, or how far, individual services should be financed by tax, contributions or charges; and an equally clear understanding that as costs rose, so automatically would contributions and charges. Contributions would be in the form of a hypothecated tax either within or outside the NI system - but administered centrally and not by competing social insurance funds. A subtext was that, whilst acute care should be paid more directly by patients, chronic care - especially 'intermediate care' for the frail elderly - should be tax-financed and thereby 'free' at the point of access.

In the meantime, the NI contribution was raised three times between 1957 and 1961. This option was most favoured because it proved to be an uncontroversial way to raise revenue. In the words of Selwyn Lloyd when chancellor, it was an 'easy way of raising money outside normal fiscal channels'. Unlike on the continent, it was heavily weighted on the employee rather than the employer. Contributions from the employer rose from 1.5d to 7.5d, and from employees from 8.5d to 32.5d. As a percentage of NHS costs, the combined contributions rose from a low of 6.4% to 17.2% (still short of Beveridge's figure). Together with income from increased charges, non-tax finance reached an all-time high of 22.7% in 1962.

The move to a full, or more fully, contributory system failed. There were contingent reasons (such as a greater need to introduce a graduated pensions scheme, which made it difficult simultaneously to raise health insurance contributions). It was mainly due, however, to issues of principle very similar to those expressed by Bevan (and indeed by the 2002 Treasury Select Committee). Within Cabinet, the NI health contribution was condemned as a regressive poll tax, levied on a limited class of people to pay for a service which was universally available.

Moreover, without an overt statement that tax was being withdrawn from the NHS to better fund other services, such as care for the frail elderly, the presentational problem arose that the extra money raised from NI contributions far exceeded any increase in expenditure on the NHS. As Macleod wrote: it was 'a bad tax because it hurts poorer families only. The figures for the NHS [estimates] increase clearly do not justify it'. Lack of transparency also wasted hours of time on interdepartmental disputes as well as impeding good government. NI contributions, it was acknowledged throughout Whitehall, were simply another tax and not part of any insurance system: the fiction was just maintained to help ease of collection. Nevertheless, there were endless debates over the expediency of raising the NI health contribution since any rise in contributions might led to the public expectation that all insurance benefits should be raised.

The Conservatives' ten-year plan 1962-1972

The drive to make the NHS fully, or more fully, contributory was halted in 1962 by Enoch Powell's appointment as minister of health. To add to the irony, despite being an economic liberal, he also revelled in the launching of the alternative Hospital Plan, which he described as 'an opportunity to plan the hospital system on a scale which is not possible anywhere else certainly on this side of the Iron Curtain'. 'Command and control policy' came into its own as the focussed turned on how the money should be spent rather than raised.

The objective behind the Plan was to remedy a decade of neglect but also to contain future rises in current expenditure by long-term capital investment. £570m was to be spent over 10 years to provide a national network of District General Hospitals throughout the UK. The Plan although a triumph of spin, was a failure in practice.

The average of £57m p.a. committed to capital expenditure was actually less than the extra £65m raised in increased charges/contributions. Moreover, annual capital expenditure had already reached about £50m by 1961. The Plan did not entail therefore, as presented, a major new initiative in hospital construction. Its one advantage was that it represented a public long-term commitment to such a level of expenditure and thereby facilitated rational planning. The 'spin' of the original Plan was compounded by that of progress reports in 1963 and 1964 which, by failing to report building delays and cost inflation, were justifiably condemned at the time as 'misleading to the point of dishonesty'.

The Plan was overhasty, being an amalgamation of plans drawn up in four months by Regional Hospital Boards with little experience of, and skills in, long-term planning. It was not evidence-based. For example, there were no estimates of future need, demographic change or optimal location of DGHs; and there was no scientific justification for bed norms or 'the ideal' of a DGH. It also seriously underestimated costs, which were to be seriously affected by a shortage of architects and builders. The critical assumption that capital expenditure would reduce future current costs was also dismissed by the Treasury as 'guff'. By 1964, the projected cost had escalated to £2000m over 26 years. The Plan, as was said at the time, was like 'giving a blind man a stick - it might help but it would not improve his sight'.

Thatcherism and path dependency in the 1980s

In the 1970s, despite Keith Joseph being at the Department of Health and Social Security (DHSS), alternative means of funding were not seriously reconsidered. When the issue was tentatively raised in opposition, advisers from the private sector lacked the experience and expertise to make viable suggestions.

In the 1980s, there were two attempts to alter the financial basis of the NHS. Both failed and resulted, ironically, in the explicit re-endorsement of the tax-based system. The alternative strategy of administrative reform was adopted. In short, the administrative and political costs of change were adjudged to outweigh the advantages, however ideologically desirable.

In 1981 a DHSS working party re-interred, without acknowledgement and apparent awareness of, most of the suggestions from 1957-1961. It was immediately dismissed, following a Cabinet reshuffle, by the new secretary of state. This was, in his words, because it promised no major savings, envisaged a continuing major role for taxation in financing the needs of those not in the workforce and was 'frankly political madness'. A report by the Central Policy Review Staff a year later, recommending inter alia private health insurance and increased charge, sparked 'the nearest thing to a Cabinet riot' and led to the promise at the 1983 Party conference that 'the NHS is safe with us'. The Griffiths enquiry, which radicalized NHS management, swiftly followed.

By 1987, the NHS was near bankruptcy because its income from government was so restricted. Even bodies such as the King's Fund were starting to consider additional, alternative sources of finance. They were also considered within government in the NHS Review chaired by Mrs Thatcher. A proposed hypothecated health tax, from which people might opt out into private health insurance, was dismissed on the grounds that it would have left the NHS with a heavily reduced income and all the bad risks. Increased charges were rejected as politically unacceptable. Increased tax incentives for private insurance, as proposed by Mrs Thatcher herself, were rejected by the Treasury as costly, complicating the tax system and unfairly advantageous to the private sector. Indeed the Treasury's survey of international practice concluded a tax-financed system offered the best means of containing costs. The subsequent white paper in 1989, Working for Patients, contained a foreword by Mrs Thatcher which promised: ' the NHS will continue to be available to all ... and to be financed mainly out of general taxation'. The alternative solution to the problems of the NHS which it proposed was the introduction of internal markets.

Implications for current policy

History cannot be prescriptive. However, debates over certain suggestions for - or initiatives in - current policy can be deepened by an injection of historical perspective.

Tax-funding. The conclusion of both the NHS Plan (2000, ch 3) and Wanless (2001, ch 4) that the NHS should remain predominantly tax-financed appears historically justified. The rejection by the Conservatives of alternative methods between 1957 and 1961, and again in 1982 and 1988, suggests that policy has become 'path dependent'. Immense dislocation, which would increase immediate costs without improving health outcomes, would attend any major change. The UK, unlike France and Germany, does not have a tradition of strong social insurance funds. They capitulated quietly in the 1940s and there were no plans to revive them in the later 1950s.

National Insurance Contributions. They have for long been acknowledged within government as an uncontroversial way to raise taxation - not least when increases to the NI health contribution was raised three times between 1957 and 1961 as an explicit hypothecated health tax. The NHS has also always enjoyed immense public support at all levels of society. This suggests

public debate on taxation could be enriched, and willing compliance to increased taxation enhanced, by a hypothecated health tax, ring-fenced to fund an explicit programme of reform - however much this might offend current Treasury accounting principles;

arguments, such as those used by Beveridge, which stress that health expenditure advantages everyone (e.g. increased social solidarity and improved productivity) can provide cross-party justification for increased taxation;

the financing of the NHS from NICs could be made more progressive. Employers, in comparison with continental Europe and the USA, have paid relatively little. The upper earnings limit within NI is also an anomaly arising from the historic fiction that NI is an insurance scheme rather than - as covertly admitted since the mid 1950s - simply another form of taxation. It is here that arguments concerning productivity and increased social solidarity ('one nation') become particularly pertinent.

Wanless (2002) appears historically justified in insisting that the terms of reference for all future reviews of the NHS should include social care. Conservative plans in the 1950s to make the NHS insurance based were designed to release resources for the tax-funded support for the frail elderly (now termed 'intermediate care'). The frail elderly were particularly disadvantaged by the 1948 settlement and this historical legacy remains.

The fate of the 1962 Hospital Plan serves as a warning against any ambitious modernization plan that is not evidence-based and honestly monitored. Increased revenue can be raised with least difficulty when there is the perception that value for money is assured. It was, after all, just such a perception by the middle-class in the 1940s and 1950s which had led the predominant interwar mix of private and social insurance being so conclusively rejected in favour of a tax-funded NHS.

About the author

Rodney Lowe is Professor of Contemporary History at the University of Bristol. He specialises in social history and welfare policy. His most recent books include Adjusting to Democracy (Oxford) and The Welfare State in Britain since 1945 (Macmillan). r.lowe@bristol.ac.uk.

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